Understanding a Business Line of Credit and Tips on How to Get One

If you own a small business, chances are you have probably experienced a shortage of cash at some point. A fluctuating economy, growing payroll, unexpected expenses or dramatic drop in sales can all cause a small business owner to worry about having enough cash ready on hand to keep everything running smoothly. Similar in concept to a credit card but with drastically lower interest rates, a business line of credit can keep your small business operating and potentially help it grow.

What is a Business Line of Credit?

While it is similar to a credit card where you make a set prearranged monthly payment and you can use the available money when needed, this convenient line of credit also has a significantly lower interest rate. This means that you will be paying back less money, which can then be put back into your business. It can be used to purchase additional supplies to help the business grow, along with keeping it operating during slow seasons.

Differences Between Business Loans and a Business Line of Credit

There are only a few slight differences between a loan and line of credit, and deciding which one is best for you will depend on your unique situation. Business loans are more structured and have a set payment that is due once a month. A line of credit also has a monthly payment but the amount can vary depending on how much was borrowed. The interest rates can also fluctuate, unlike a loan where it is fixed unless it is refinanced.

Why Get a Business Line of Credit for a Small Business?

Many small business owners are realizing that there are several reasons why a line of credit can help them grow and flourish. Once the application has been approved, you can start using the available funds for almost any of your business needs. The line of credit can be used to cover unexpected repairs and to replace or update necessary equipment. These funds can help cover your payroll during slower seasons, along with ensuring your business is fully stocked and ready for sales and promotional events. A line of credit can also be used to jumpstart a marketing campaign to help your business grow and prosper.

Tips on How to Get a Line of Credit

Once you have decided on a line of credit over the more structured business loans, there are a few tips that will make the process easier, along with helping you get approved.

  1. Build a strong credit history.

One of the most important things any small business owner can do is to start building a good credit history from the time they make their first sale. Even when money is tight it is always important to pay bills on time, and to establish utilities in your name. When this is combined together lenders will generally have a more favorable impression of your business.

  1. Do your homework.

It is important to do plenty of research on banks and other lenders for taking out business loans. You want to be familiar with their general terms and policies before you apply for a line of credit. If you have a low credit score there are non-traditional lenders who specialize in working with these types of small businesses, and it is still important to do your research before you sign any contract.

  1. Show that you have a positive cash flow.

While there is always the possibility of getting a secured line of credit, this might not be necessary if you can show that your business can generate a positive cash flow. Any potential lender will be carefully scrutinizing all of your past and current business records, along with any predictions for the future. Your business’s ability to generate a positive cash flow will also help to determine the interest rate, along with the amount you have access to and if your business qualifies for the preferred unsecured line of credit.

  1. Don’t overuse business or personal credit cards.

Some business owners make the mistake of maxing out their credit cards. While this may seem like an instant fix, it is only a temporary solution to your business’s cash flow problem. The large credit card bills will not only be difficult to pay back on time if your business is already strapped for cash, but it will be looked at unfavorably by any potential lender. Maxed out credit cards make it difficult for your business to show a positive cash flow, and you also have to deal with the exceptionally high interest rates. Simply taking the time to fill out the application for a line of credit can potentially save your business thousands of dollars in the long run.

  1. Remember to start small.

A business line of credit/ business loan is similar to your first credit card, where you want to try and only make necessary purchases and pay the balance in full each month. Not only will this keep you from having to pay interest fees on top of the loan, it will also help build and strengthen your credit and reputation with the lenders. When you start to show a positive cash flow by making your payments in full and on time your business’s reputation will grow and soon you will be eligible for larger lines of credit.

  1. Apply before your business really needs the money.

This might sound silly to some people, but it is actually good business advice. There are several reasons why it is recommended to apply for a business line of credit before your business is experiencing a serious cash flow problem. While you don’t want to take out a ridiculously large line of credit, a smaller one can help your business conserve cash for leaner times. It can also help you build and establish a strong reputation with the bank, along with helping to improve your own credit rating.

Most business owners have also discovered that it is easier to get a line of credit when they don’t need it, simply because their business is currently generating a positive cash flow. Once you have established your business’s reputation with a lender, it will be easier to get the line of credit you need when your cash flow is tight.

Important tip: It is important to remember that a line of credit needs to repaid monthly just like a credit card bill or traditional loan. This means that you want to be careful and not max out your credit cards while also using a line of credit. The payments can easily build up to ridiculously high amounts, and your business can quickly go into serious debt. Being responsible and managing your money properly is one of the first rules anyone should learn before starting their own business.

A Few Final Considerations

A line of credit for your business is an excellent way to build a financial reputation, along with keeping everything running smoothly during slow seasons. While banks are available to offer most businesses a line of credit, there are some that might not qualify with a traditional lender. There are non-traditional lenders that are willing to help businesses with poor credit and most offer the same low interest rates that you would normally get from a bank.

If you are wondering how much extra cash you should apply for, it will typically depend on your unique business needs. A 2002 article in the New York Times by American Express recommends deciding on an amount that covers your typical operating costs, with around 20 percent of the line of credit still available to put towards any unexpected emergencies.

The most important thing to remember before taking out a line of credit for your business is to research any potential lender thoroughly. Know exactly what you can afford to repay each month and do not take more than you actually need. As long as you use common sense and self-control, a line of credit can help your business grow and succeed.

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